Dealing Desk or Non Dealing Desk? – The SNB Aftermath

01/19/201501/19/2015 by Editorial Team

Last week’s Swiss National Bank shocker caught the markets off guard posting heavy casualties which was felt more with the retail forex trading industry. Traders and brokers alike got caught up in a black swan event which led to quite a few brokers going bust while some reputable brokerages seeking capital to continue to keep up with the operations.

The event has also given rise to the age old debate of which of the two main models of trading execution is better, market makers (also referred to as dealing desk brokers) or agency model brokers (referred to as non dealing desk brokers). In the aftermath of the Swiss shocker, in a typical reactionary mode, market makers were hailed as the heroes as they (the brokerages) managed to come out unscathed.

But does this one instance justify hailing the market makers as the go to forex brokers? We doubt and here’s why.

What are market makers anyway?

Market makers or dealing desk brokers are the ones who act as a counter party to your trades. In other words, when you buy, they sell and when you sell they buy. One evidence, that clearly comes up from this model is that with a market maker, there is no lack of liquidity because the broker is expected to pick up your order no matter what.

In the retail forex trading industry, market maker brokers are often judged upon with suspicion. After all, how can a market maker broker make profits if their clients keep winning all the time?

Well, the above statement needs to be taken with a pinch of salt. Not all market maker brokers are out there to get your money. Besides being a counter party risk to your trades, market makers also make their profits by marking up the prices by a few pips. It is therefore common to find these brokers being referred to as fixed spread brokers as well.

What are non dealing desk brokers?

Non dealing desk brokers operate their business in the true sense of the name, “broker”. NDD brokers typically either charge a commission on your trade or a spread mark up and in some cases, both. When you trade with a NDD broker, your forex broker is not the counter party, but rather your trades are automatically passed on either to their trading network (known as ECN) or to the interbank markets (liquidity providers).

NDD brokers therefore usually offer variable spreads, but tight or competitive spreads especially if they have quite a few liquidity providers.

Having a basic understanding of the two main brokerage types, let’s analyze the events during the SNB shocker.

What did the Swiss National Bank do?

The Swiss National Bank had maintained a fixed exchange rate to the Euro. In other words, 1 Euro bought you 1.20 Swiss Francs. By maintaining a lower exchange rate to the Euro, the Swiss Central Bank wanted to ensure that their exports remained competitive (which justifies considering Eurozone being the Swiss’ largest trading partners). Given that the Swiss were maintaining the fixed exchange rate, retail traders (and institutional investors) were constantly assured by the Swiss Central Bank officials that they would maintain the floor on the Swiss Franc.

The retail markets simply used this as an opportunity to buy the Euro and selling the Swiss Franc, every time prices came close to the 1.20 level.

On 14th January 2015, the Swiss National Bank Governor Thomas Jordan announced that they would no longer maintain the floor of 1.20. This created a shock as the Swiss Franc soared in value. All the traders who were short on the Swiss Franc were left on the “opposite side” of the trade.

Because there were no pending buy orders below 1.19, the stop losses failed to trigger, leaving the traders heavily exposed. Add leverage to the puzzle and you can imagine the amount of losses traders took. Due to this factor, most of the traders who had any open positions (as well as pending orders) ended up with a large negative account equity (meaning that they owed their broker money) which ran into triple digit losses at the very minimum. However, reputable brokers such as FxPro which had their risk management policies in place managed to emerge out of the chaos with little to no scars. They were also quick to forgive the negative account balances of their traders.

Non Dealing Desk brokers were obviously hit because their liquidity providers were simply not able to provide the bids or offers below the 1.2, 1.19 price range.

Market makers on the other hand, acting as a counter party to their traders, were obviously positioned on the long side of the CHF. This meant that while their traders took a loss, the market makers managed to emerge clear winners with a huge profit.

While the debate about market markets vs. non dealing desk brokers continues, one question that needs to be asked is at what prices were the CHF orders filled for the traders who had taken short positions (selling CHF). Did the clients of Market maker brokerages manage to exit exactly at the price where they set the stop loss orders or did they in fact experience slippage with their stop loss orders being filled at a worse rate?

While we may not get immediate answers to the above question, it would be well worth bearing this question in mind. After all, if the above SNB event managed to bring out the skeletons from the closet, in terms of inadequately funded non dealing desk brokers, it would perhaps be a matter of time before we also get to hear from the market makers and the possibility of taking advantage of the situation. Only time will tell.

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